Best Case: Transparency in Microfinance

Microfinance, originally a donor-funded innovation of the non-profit world, now more often makes headlines for its movement towards commercialization. As the debate about profit and social responsibility heats up, the importance of pricing transparency is growing increasingly apparent.

Microfinance, originally a donor-funded innovation of the non-profit world, now more often makes headlines for its movement towards commercialization. As the debate about profit and social responsibility heats up, the importance of pricing transparency is growing increasingly apparent. Microfinance has long been a highly transparent industry, but unfortunately the true prices of microloan products have rarely been accurately measured or reported and remain widely misunderstood. In its next phase of development, improvements in interest rate disclosure and the standardization and communication of prices will be essential to the functioning of a healthy, sustainable microfinance industry.

The Evolution of Non-Transparent Pricing

One of the main reasons that non-transparent pricing in microfinance has evolved and spread is that the prices of microloans are usually higher than those of mainstream loans. The cost for a microfinance institution (MFI) to grant a loan is fairly flat relative to loan size. This means that the cost represents a higher percentage of the loan amount for smaller loans. Therefore, in order to cover the costs of these smaller loans, MFIs must charge higher prices than they would for larger loans.

Due to the challenges of explaining why MFIs need to charge higher interest rates than the commercial sector, and have to charge the poorest clients the highest interest rates, the easier alternative has been to use pricing methods where the quoted price appears significantly lower than the actual price. Once the industry began widely employing confusing product pricing, it became very difficult for any single MFI to maintain transparent pricing. To do so would leave that MFI advertising what appeared to be the highest price on the market, even though their true price could actually be the lowest. As a result, the vast majority of MFIs practice non-transparent pricing even though many would prefer to do otherwise.

In many countries, non-transparent pricing practices have proliferated in the absence of the type of truth-in-lending legislation that protects borrowers in the United States. Such laws were enacted to help consumers make informed decisions loans that seem comparable, though in actuality one loan is significantly more expensive. Coupled with the fact that many microfinance clients are poorly educated, illiterate and have no knowledge of formal financial products, it is nearly impossible for borrowers to make informed decisions about the products available to them. An important question for us to consider is: Shouldn’t the same principles of transparent pricing applied in the commercial finance industry in many countries also apply to the microfinance industry?